Mistake #1 Focus Solely on Investment Returns
As we save for retirement, we are constantly reminded to systematically add to our 401k and investment accounts and not to worry about the volatility that the stock market constantly experiences. That is generally solid advice if you are in a properly diversified portfolio. History shows us that the market as a whole has never failed to reach new heights if given enough time to recover. When we routinely add to our investments, we take advantage of market downturns because our dollars buy the discounted shares and profit in the rebound. This is commonly referred to as “Dollar Cost Averaging”. The majority of people who have successfully built their retirement nest egg have benefited from this strategy.
The truth is, the very strategies that have helped you build a substantial retirement fund could very well work against you as you draw out income during your retirement. The math of retirement income generation is very different from the accumulation phase and failing to understand this may place your entire financial well being at unnecessary risk. Your long term rate of return is not a benchmark that can reliably predict the success of your retirement income strategy. Volatility control in your retirement income years is essential to creating a dependable income stream. You can no longer afford to wait out a bad year like many of us experienced in 2008. A large loss coupled with income needs that further draw down your investments could become more than your portfolio can sustain. In retirement, the sequence of market returns will overshadow the need for a bigger total investment return.
Mistake #2 Failing to Account for Inflation’s Impact
The last decade has been a relatively tame period for inflation. It is easy to discount the possibility of higher inflation eroding the purchasing power of your portfolio if we only look back a few years. A little longer view tells a different story of rising prices, with double digit inflation rates in the late 1970s. Inflation hits retirees particularly hard because their income sources such as pensions and social security tend to do a poor job of keeping up with surging prices. Even in low inflationary periods, retirees can get hit hard if inflation is centered around items that retirees tend to consume more of, such as health care.
If you have planned your retirement income needs for the next 25 to 30 years and have not taken inflation into account, you will likely find your lifestyle squeezed by rising prices. For instance a 3% inflation rate doubles the price of goods in approximately 24 years. In other words, if it takes $5000 per month for you to feel comfortable today, it will demand $10000 to enjoy the same quality of life over a typical retirement period. I find most people do not fully appreciate the power of even a modest inflation rate over the course of time. If your plan does not account for this, your golden years may not live up to your expectations.
Mistake #3 Becoming Too Conservative
It is very natural to want to avoid the volatility of the markets as we enter into retirement. We know that we no longer have the time to wait for the market to bounce back and we also know that if something goes wrong, without income from a job, there is little chance to make up the lost ground. Psychologically, the pain of portfolio losses are amplified in retirement. The dilemma here is that without the upside of the market, you expose yourself to the potential loss of purchasing power through inflation or the depletion of your investments by spending the principal. Essentially, to avoid Mistake #1, you are subjecting yourself to Mistake #2.
Let’s say several years back you retired and purchased a bond or a CD with a safe 6% rate of return to fund your retirement. If the investment would have happened to mature the past few years, chances are you would only be able to find 1-2% return on your reinvested money. Your retirement income would have fallen by more that 60% while your principal would not have grown. Could you live your same lifestyle if you income were cut by 60%?
Most people only define risk as the loss of principal, however loss of purchasing power, reinvestment and sequence of return risks can be equally as detrimental to your financial well being. The extreme aversion to one type of risk may unknowingly expose you to risks you have not considered.
The truth about your financial planning is that it is impossible to avoid all risks that you will face over the years of retirement. There is no perfect investment and a sound plan will incorporate various strategies and investment options to strike the proper balance to achieve the desired outcome with the highest probability. Your plan will need to have a degree of flexibility to deal with investment environments that are largely unpredictable over time. The good news is that the investment professionals at Fourth Avenue Financial have decades of experience and have guided hundreds of clients through the retirement planning process. You only retire once and your plan has to be done right the first time. Put our team’s collective experience to work for you.
Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. Advisory Services offered through J.W. Cole Advisors, Inc. (JWCA). Fourth Avenue Financial and JWC/JWCA are unaffiliated entities.
Fourth Avenue Financial
170 Court Street Charleston, WV 25301
Charleston, WV – (304) 746-7977
West Caldwell, NJ – (973) 218-5800
Dublin, OH – (614) 675-5913
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